At least three exchanges in the U.S. that traded the digital currency Bitcoin have shut down, apparently as a result of guidance
issued last month by the Financial Crimes Enforcement Network. That
agency has emerged as the top threat, at least in in the United States,
to the decentralized Bitcoin network – moreso than the widely reported
price volatility and hacker attacks.

"They've been the single biggest factor for stomping out currency competition," says Bradley Jansen, a former assistant to Rep. Ron Paul and director of the Center for Financial Privacy and Human Rights. Speaking recently on The Daily Bitcoin
podcast with Adam Levine, Jansen expressed surprise at how little focus
bitcoin business leaders are putting on Fincen, especially considering
how regulators thwarted earlier emerging payment systems like PayPal and
e-gold. PayPal obviously survived and prospered – but only after
selling itself to eBay and agreeing to put restrictions on its service. E-gold was not so fortunate.

"Fincen
was able to stop currency competition with technical innovations in the
90s even before their expanded powers under the U.S. Patriot Act. And,
what we've got now is a Fincen on steroids without clear restrictions
from Congress," Jansen says.

The guidance requires certain
intermediaries that handle virtual currency to register with Fincen as
money services businesses, which entails recordkeeping and reporting
responsibilities. And it says some of those businesses may additionally
be money transmitters, which would mean fingerprinting of directors and
officers and compliance with a patchwork of state licensing
requirements.

Jansen postulates that the recent Fincen virtual currency guidance was issued ex post facto as a way to set the stage for potential prosecutions in the future.

"It's
a failure of Congress to do its job. We knew that these guidelines and
these prosecutions were in the works even last Congress. Ron Paul was
the chairman of the House subcommittee that had jurisdiction over Fincen
and he never had a single hearing on this."

In a recent speech,
Fincen Director Jennifer Shasky Calvery said the new guidance aims "to
protect [digital currency] systems from abuse and to aid law
enforcement in ensuring that they are getting the leads and information
they need to prosecute the criminal actors." She reiterated that the
guidance does not apply to everyday users who pay or accept bitcoin for
goods and services.

But by saddling startups with compliance
requirements, and making them unattractive clients for regulated banks
that despair of serving MSBs, Fincen is choking these businesses that
facilitate conversion of bitcoins into dollars. Fewer exchanges and more
red tape will make it harder for merchants or consumers (who, after
all, must still pay the bills with dollars) to take advantage of the
Bitcoin payment system’s speed, privacy and competitive costs.

On March 20 – just two days after the guidance from Fincen came out – the bitcoin exchanger bitme.com suspended
operations indefinitely. Bitme was a relatively small operation, but it
was widely suspected among bitcoin users in online forums that this
closure resulted from difficulties related to potential regulatory
compliance.

BTC Buy, another bitcoin exchange site, suspended services and closed permanently in early April, specifically citing the legal uncertainty brought up by the Fincen guidance.

Most recently, the largest bitcoin exchange to halt
trading was Bitfloor, run by Roman Shtylman, who blamed "circumstances
outside of our control." His New York operation had average daily
trading volume of about $300,000 (depending on the exchange rate), with
U.S. dollar deposits and withdrawals running through a Capital One bank
account – which the bank unilaterally closed. "I had very little time
to act between receiving the account closure letter and the account
being closed," Shtylman told PaymentsSource.

In this case, the
regulatory guidance may have had an indirect effect. Bitfloor was
registered with Fincen as an MSB but was not licensed as a state money
transmitter. Shtylman surmised that Capital One had judged his business
to be "not worth the risk."

Across the Atlantic and presumably unrelated to Fincen, Poland-based Bitcoin-24 suspended trading after the government there froze its bank account.
It reportedly did so because a bank in Germany complained of
compromised accounts transferring stolen money without identification to
Bitcoin-24. Also, U.K.-based TransferWise,
a foreign currency intermediary, ceased transfers to any bitcoin
exchanges at the request of its banking partners. TransferWise had
mostly been servicing customers in the U.K., Poland, and Spain.

It
will be interesting to watch how Fincen intends to treat one-way,
fixed-rate brokers that either buy or sell bitcoin at a fixed price.
Since a two-way exchange market is not involved it could be seen as
merely a typical commodity purchase or sale.

Tangible Cryptography LLC, which registered as an MSB this month, operates FastCash4Bitcoins for selling bitcoins and Bitcoins Direct
for private off-exchange purchases. The two businesses function
independently of each other and neither is technically an exchange.
Bitcoins Direct is frequently closed to new clients and its cash deposit
feature was recently cancelled.

The fact that bitcoin survives at all with so many powerful forces lined up against it is a testament to its resiliency and tenacity. Now, in addition to the vicious press coverage
and persistent denial of service attacks on exchanges, the emerging
cryptographic money has to contend with onerous and targeted regulation.

With respect to bitcoin and financial regulation, Jansen warns: "I
think the lesson from the 90s was that you either become what Fincen
wants you to be or you're not going to be."

Not in the
U.S., that is. But jurisdictional competition will kick in and overseas
exchanges will gain market share and liquidity. They just may not have
U.S. customers.

The Bitcoin Foundation is an excellent template
for a decentralized nonprofit project and I am proud to serve alongside
the other dedicated board members on such a historic effort.

Established seven short months ago, the foundation
has recruited bitcoin’s lead developer (transparency of compensation is
important), launched a grant program for funding bitcoin-related
initiatives, and coordinated a showcase conference
in San Jose. About 60% of our membership comes from outside the U.S.
and we are currently seeking partners for local chapters in foreign
countries which will increase global effectiveness.

Additionally, the foundation maintains an active relationship with
various press entities seeking information about Bitcoin and the role of
the nonprofit foundation. Since these inquiries come from around the
world, we strive to be inclusive and we enlist the voluntary support of
foundation members and regional affiliates for certain questions because
they would best know their local bitcoin markets. We also refer many
technical questions on cryptography and bitcoin mining to contributing
developers. Frequently and on short notice, the press wants examples of
bitcoin users in a particular country that are willing to speak openly
with the media and sometimes on camera so we do our best to accommodate
that.Media opportunities often lead to conference
opportunities. Ultimately, this work expands the market for bitcoin
education. Conference organizers and media outlets also reach out
directly to executives at existing bitcoin businesses and other
professional analysts that are known from previous appearances. If a
publication or television station seeks a certain individual for
political commentary, that can be found quite easily on Twitter or the
Bitcoin Forum. Social media has vastly increased the opportunities for
people willing to speak.

It’s not always about taking a position on political or human rights
issues. Mostly, it’s about freedom of choice in currencies and economic
education on bitcoin price movements, bitcoin exchange markets, bitcoin
merchants, potential regulation, and the differences between Bitcoin as a payments network and bitcoin as a monetary unit. Or, it’s about specific use cases such as asset protection in Cyprus or maintaining donation payments in support of freedom of the press.

The foundation itself is nonpolitical, so when an inquiry comes from an industry regulator, our role is to explain what is and what is not
possible in terms of potential regulation. I believe this approach to
be the most effective stance to take when confronted with regulatory
queries. Fortunately, Bitcoin transcends the conventional philosophy of
regulation by reducing certain aspects to irrelevancy.

For instance, bitcoin exchange endpoints where bitcoin interfaces
with national fiat money and the banking system is a possible point of
regulation due to current AML and KYC guidelines in most countries.
However, due to the nature of distributed computing, ongoing
transactions between individuals and companies would be technically
outside the scope of potential regulatory action as long as there is
electricity and internet connectivity.

Debates around gambling and personal drug use are moral issues. An
apolitical currency like bitcoin is simply a network protocol, like
email or telephone, so it is unable to express a morality.

To date, this educational approach has been effective because only
four jurisdictions and one central bank have published any formal
statements on the Bitcoin cryptocurrency — Norway, Australia, France, United States, and the ECB. With the exception of the recent U.S. FinCEN regulatory guidelines, all of the reports have been explanatory in nature.

Open source development projects while extraordinary in many respects
are actually not very good at “staying on message,” whatever that
means. And with Bitcoin, there’s no reason that they should be because
there isn’t a single message. The diversity of what attracts different
people to Bitcoin is one of its greatest strengths. Free market
economists admire the separation of money and government while
audit-minded accountants relish its public traceability. Even Paul
Krugman secretly covets bitcoin’s abstract nature for a future Federal Reserve digital currency.

However, being against dissenting viewpoints on regulation, being
unwilling to confront any form of taxation, or being anti-financial
privacy does not make one a neutral bitcoin advocate as some have
suggested. Those positions are the worst sort of bias because from the
outset they wrap ideology in what is politically correct and easily
digestible by the masses. Furthermore, it can be disingenuous and
manipulative.

Either way, Bitcoin is the honey badger of currencies and the
protocol rolls on. Hat tip to Gavin Andresen for locating this media
theme song.

With bitcoin in the media spotlight, everyone seems to have an
opinion on the price. Few recognize the profound implications of
decentralized money for the monetary system, society and government –
not to mention the emerging business opportunities.

The timing could not be better for the inaugural conference of the newly-formed Bitcoin Foundation.
Next month, several hundred people from around the world will converge
on the San Jose Convention Center (in Silicon Valley, naturally). Billed
as "The Future of Payments,"
the conference is attracting technologists, venture capitalists,
bankers, traders, payments specialists, and financial regulators.

Launched
in January 2009, bitcoin achieved all-time highs in transaction volume
and new entrants into the currency last week – milestones overshadowed
by the price volatility. The nonprofit foundation was established
in September 2012 to standardize and promote the core bitcoin protocol.
(I have a seat on the foundation’s board.) Two of its early
accomplishments were to recruit lead bitcoin developer Gavin Andresen
(whose informal role in the Bitcoin community mirrors Linus Torvalds’
position in the Linux world) as chief scientist and to launch a
quarterly grant program for funding various initiatives that advance the
bitcoin protocol. Next, the foundation intends to encourage best
practices for bitcoin businesses and exchanges, to facilitate the
formation of local foundation chapters in foreign countries, and to
educate global regulators about what can and cannot be regulated
feasibly with a distributed peer-to-peer system such as bitcoin.

Although
the conference features excellent technical tracks, the agenda will be
particularly interesting to those in the banking and payments fields.

For
example, many people understandably ask why merchants would want to
accept payments in Bitcoin given the volatility of the exchange rate
with the dollar. After all, even if you believe the digital currency
will appreciate over time, you probably can’t use it to pay the electric
bill or the rent.

Part of the answer is the service provided by firms like BitPay,
whose cofounder and CEO, Anthony Gallippi, will explain how he’s been
driving business adoption of Bitcoin. BitPay functions as a merchant
payment processor, somewhat akin to the acquiring banks in the
Visa/MasterCard space. The startup provides foreign exchange conversion
services for merchants desiring immediate settlement in local national
currencies. Thus Tony’s customers reap the benefits of Bitcoin – no
chargebacks, since bitcoin transactions are irreversible, and lower fees
than they’d pay for credit card transactions – while BitPay takes the
currency risk. Tony recently landed one of the best-known merchants to
accept Bitcoin: WordPress, the blogging platform.

Another startup is Paymium,
whose Bitcoin-central exchange has shown it is possible to seamlessly
integrate bitcoin and the traditional regulated banking infrastructure.
The French company’s co-founder and chief operating officer, Pierre
Noizat, will talk about bridging that gap. If his name rings a bell for
some financial services professionals, it may be because Pierre comes
from the traditional payments world, having served as managing director
of the French Mobile Contactless Association.

Would-be
disruptors eyeing this space but worried about legal uncertainties will
have a chance to hear from Patrick Murck, the general counsel of the
Bitcoin Foundation. His expertise extends across the legal and
regulatory issues governing the use of Bitcoin, virtual economies,
gamification, alternative payment systems, and social loyalty and reward
programs. Immediately after the Financial Crimes Enforcement Network
issued the March 18 regulatory guidance on centralized and decentralized
virtual currencies, Patrick published an analysis.

Bitcoin’s
user-defined anonymity protects personal privacy, and this combined
with the decentralized structure arguably thwarts censorship – for
example by allowing people who want to donate to WikiLeaks to circumvent
the political blockade that forced the major payment processors to cut off that organization. Rainey Reitman, the activism director of the Electronic Frontier Foundation,
a nonprofit civil liberties law firm and advocacy center, will hold
forth on these liberating aspects of Bitcoin. She is particularly
interested in the intersection between personal privacy and technology,
and has spent significant time investigating the role of financial
intermediaries as censors. Reitman is also the chief operating officer
and co-founder of the Freedom of the Press Foundation,
a nonprofit organization that crowd-sources funding to supporting
independent, nonprofit journalistic institutions – and recently started
accepting bitcoin.

Most of the attention paid to Bitcoin in the mainstream media has focused on its merits and drawbacks as a store of value. The smarter commentators
have paid greater attention to its potential as a means of exchange.
But what about the third key role of money, as a unit of account?
Bitcoins, after all, are divisible to the eighth decimal place, and this
is another disruptive component. Erik Voorhees,
a bitcoin early adopter involved in several leading bitcoin-related
companies, such as BitInstant, SatoshiDice and Coinapult, will encourage
thinking on this as he discusses the economics of Bitcoin and its role
as money.

Ever since the bitcoin cryptocurrency launched and
achieved initial success, institutional investors and hedge fund
managers have secretly sought a regulated investment vehicle for bitcoin
placements. Malta-based Exante Ltd. has a solution with its new Bitcoin Fund. There remains a case for Bitcoin as a store of value, even after the recent whipsawing. Tuur Demeester, author of the financial newsletter MacroTrends,
added bitcoin as part of his recommended currency basket in January
2012, and he’ll talk about bitcoin's emerging role as a separate asset
class alongside precious metals, equities, and bonds.

Wednesday, April 24, 2013

Yesterday, Adam B. Levine, editor-in-chief of The Daily Bitcoin,
interviewed Bradley Jansen for "Let's Talk Bitcoin" about the US Treasury's
Financial Crimes Enforcement Network (FinCEN) and their recent guidance
on alternative currencies such as Bitcoin. According to Jansen:

"What we've got now is a FinCEN on steroids without clear restrictions from Congress!"

Tuesday, April 23, 2013

A piece from Paul Krugman in The New York Times
this week criticizes bitcoin for being antisocial and for not having a
State-controlled supply while secretly admiring its powerful
abstractness.

As a complicit minion in the State’s appropriation of the monetary unit, Krugman perpetuates ‘The State Theory of Money’ myth that the sovereign’s power to collect taxes and declare legal tender imbues a currency with ultimate value.

While that may be a reason to acquire a certain amount of government
fiat currency, it is a transitory value because in the end it is still
based on a State-sanctioned illusion. Anyone who has visited a weekend
flea market has noticed the old coin and currency collector displays
filled with past experiments in national fiat money. Those paper notes
were at one time valued for something too.

We don’t want a pristine monetary standard untouched by human frailty
as Krugman claims. We want freedom in the monetary standard untouched by the politicizing process.

In a Krugman world, centralized management of the money
supply is preferable to a market-based outcome because the
academically-informed economists will serve the best interests of the
economy at large. However, our monetary overlords possess no special
knowledge or secret sauce that justifies dictatorial control over money
any more than it would justify dictatorial control over the market for
something like soda beverages or dog food. Trust in mathematics trumps
trust in central bankers.

The question of political control over a monetary system is the
greatest litmus test for discovering those that seek control over
others. Usually, it will be cloaked in terms like full employment, price
stability, temporary stimulus, quantitative easing, and economic
growth, but manipulation of the money supply serves only to favor the
issuers of that particular monetary unit.

Money has a lot in common with religion. At some level, it requires a
huge leap of faith. Yes, a belief in gold requires this too as the
non-monetary value assigned to gold is probably no more than 5% of its
market price. However, this is also what makes bitcoin the ultimate social
money because for its value it merely requires others, not the law.
Money is already the most viral thing on the planet and the network
effect exponentially reinforces that.

Krugman actually struggles to assert that bitcoin is antisocial
because he cites economist Paul Samuelson who once declared that money
is a “social contrivance,” not something that stands outside society.
Samuelson is absolutely correct on that point and bitcoin stands firmly
within society. It is no one’s right to question why some place value on
bitcoin and some do not since all value is subjective. The rationale
for assigning value to bitcoin is as varied as the human fabric itself.

In this context, society can be defined as those mutual users willing
to agree to a medium of exchange and a store of value. Since bitcoin,
just as the Internet, recognizes no political boundaries, Krugman
resists seeing the global monetary unit as something social. Krugman sees society only as a multitude of aggregated fiefdoms where he is the emperor’s cherished tailor.

Though, just like the untainted child in the Hans Christian Andersen
fairy tale, some of us are beginning to notice. It’s not the illusion
itself that so offends our sensibilities, but more the notion that a
competitive illusion is not to be permitted. If a free market illusion
voluntarily agreed to from the bottom up is so desperately feared, then
the protectors of the State-sanctioned illusion must not have the most
benevolent of motives in store for us plebeians.

I don’t know about you, but I for one can stand up and exclaim: “the fiat emperor has no clothes!” What if more of us did?

She explains again
how the Financial Crimes Enforcement Network (FinCEN) gets its data
from the reports it mandates that banks use to spy on their customers
against them. Lots and lots of reports.

But she promises:

"However, right now this is long and arduous work as
analysts sift through hundreds and sometimes thousands of reports. Very
soon, new capacities made possible by our internal technology
modernization will allow our analysts to deal with such data sets to
find leads in a fraction of the time previously necessary. Very soon, we
will be able to point law enforcement and other stakeholders precisely
to where they should be looking. Our analysts, working hand- in-hand
with our superb technology team, are now putting these new capacities
into place."

But her talk really focused on "Emerging Payment Systems." Her
comments have echoed mine (from an entirely different perspective) that
technology (and specifically mobile apps) offer great opportunities (for
free banking) and that those not well served by our current system (the
"unbanked" in the US--immigrants,
poor, racial and ethnic minorities--and people in countries with less
mature financial systems or sound currencies) are a great target market.

"As we all know, during the past decade, the development
of new market space and new types of payment systems have emerged as
alternatives to traditional mechanisms for conducting financial
transactions, allowing developing countries to reach beyond
underdeveloped infrastructure and reach those populations who previously
had no access to banking services. For consumers and businesses alike,
the development and proliferation of these systems are a significant
continuing source of positive impact on global commerce."

Don't worry, FinCEN is working to strangle these initiatives in their crib with their regulations. She pays special attention to "crypto-currencies" in her talk.

"We’re viewing our analytic work in this space as an
important part of an ongoing conversation between industry and law
enforcement. While probably most of today’s audience understands what
these emerging payments systems are and how they work, many line
analysts, investigators, and prosecutors in law enforcement may not, and
part of FinCEN’s role is to help be the bridge to explain these new
systems. FinCEN is dedicated to learning more about digital currency
systems, along with other emerging mechanisms, to protect those systems
from abuse and to aid law enforcement in ensuring that they are getting
the leads and information they need to prosecute the criminal actors. As
our knowledge base develops, in concert with you, we will look to
leverage our new capabilities to identify trends and patterns among the
interconnection points of the traditional financial sector and these new
payment systems.

In addition to developing products to help law enforcement follow the
financial trails of emerging payments methods, FinCEN also develops
guidance for the financial industry to clarify their regulatory
responsibilities as they relate to emerging areas."

And, as our Bitcoin fans know--at least those who follow my posts here or my rants on our Facebook page, FinCEN has "virtual currencies" in their sights. And, remember too, it was FinCEN that shut down e-gold back in the day and crippled the crypto-currency movement last century.

I'll quote her in the entirety of her virtual currency remarks:

"In fact, just last month, FinCEN issued interpretive guidance to clarify the applicability of BSA regulations to virtual currencies, such as Bitcoin, which has in recent weeks gained significant attention. The guidance responds to questions raised by financial institutions, law enforcement, and regulators concerning the regulatory treatment of persons who use virtual currencies or make a business of exchanging, accepting, and transmitting them.

FinCEN’s rules define certain businesses or individuals as money services businesses (MSBs) depending on the nature of their financial activities. MSBs have registration requirements and a range of anti-money laundering, recordkeeping, and reporting responsibilities under FinCEN’s regulations. The guidance considers the use of virtual currencies from the perspective of several categories within FinCEN’s definition of MSBs.

The guidance explains how FinCEN’s “money transmitter” definition applies to certain exchangers and system administrators of virtual currencies depending on the facts and circumstances of that activity. Those who use virtual currencies exclusively for common personal transactions like receiving payments for services or buying goods online are not affected by this guidance.

Those who are intermediaries in the transfer of virtual currencies from one person to another person, or to another location, are money transmitters that must register with FinCEN as MSBs unless an exception applies. Some virtual currency exchangers have already registered with FinCEN as MSBs, though they have not necessarily identified themselves as money transmitters. The guidance clarifies definitions and expectations to ensure that businesses engaged in similar activities are aware of their regulatory responsibilities and that all who need to, register appropriately."

The second half of her speech talked about account takeovers via
malware, risks with third party payment processors, improvements they
are making to their analytical work (after some false starts!),
their public-private partnerships with industry, and her personal
initiative "The Delta Team" ("The purpose of the Delta Team is for
industry, regulators, and law enforcement to come together and examine
the space between compliance risks and illicit financing risks. The goal
is to reduce the variance between the two.").

And let's not forget FinCEN's dreams of global domination. They are
in a partnership of 130 other "Financial Intelligence Units" as part of
the Egmont Group.

Beyond stable isotopes and naturally-occurring materials are the superheavy elements or SHEs. Scientists have recently added
two new man-made elements to the periodic table — flerovium (element
114) and livermorium (element 116), with chemical symbols Fl and Lv.

After being created by smashing atoms together, these materials decay within seconds but long-lived SHEs are a theoretical possibility. This undiscovered
region in the periodic table where heavy elements become stable again
is known as the “island of stability,” first proposed by Glenn Seaborg
in the late 1960s. If individuals prefer something more tangible over an
amorphous cryptocurrency like bitcoin, then the edges of molecular
matter in a nanotechnology future may hold the answer.

If some form of physical specie is even useful in an era of
ubiquitous artificial molecular machine systems, money would still
require certain attributes such as being a store of value, divisible,
portable, safe, unable to counterfeit, and self-validating.

Nanotechnology scientist Robert Freitas suggests that the future of money lies with elements like flerovium, or what he refers to as tangible nanomoney. Flerovium
is a radioactive chemical element first created in 1999 at the Flerov
Laboratory of Nuclear Reactions in Dubna, Russia by colliding
Plutonium-244 and Calcium-48 nuclei. Prior to May 30th, 2012, the
unstable isotope was known as ununquadium.

After restricting his analysis to ordinary matter, as opposed to
antimatter, Freitas compares the rarest elements along the natural
isotope spectrum of potential monetary candidates such as technetium,
helium, xenon, osmium, tantalum, and gold (however in a nano-age, easily
extractable inert rare elements will have alternatives). Ultimately
concluding that a man-made superheavy element like flerovium best fits
the overall criteria for physical specie, he describes how the element
could likely be introduced into society circulating as coinage.

A flerovium coin would be fused with cheaper bioinert materials of
the nano-age such as gold, platinum or diamond. Such a coin would be
sufficiently costly to manufacture and have a relatively long half life,
possessing negligible radiation and biotoxicity risk due to the very
low concentration of SHE trace amounts.

These hypothetical SHE coins would be stable and long-lived. Freitas estimates that a coin with $1 million face value would only need to contain 10⁹ SHE atoms worth $0.001/atom. Therefore, assuming a
10⁶-year half life, there would be only ~2 disintegration events per
day putting it well below the disintegration levels of today’s base
metal coinage. Rather than suffering from the insidious effects of
government-induced inflation and coin clipping, market-based nanomoney
would lose value due to radioactive decay. A million-dollar coin would
lose approximately ~$0.50 per year or ~$500 per millennium from
disintegration.

In addition to flerovium, Freitas admits that some other relatively
stable superheavy elements may also be “coined” for the ultimate
tangible nanomoney. So that’s the choice for our nonpolitical money of
the singularity — low radiation coinage or digital bitcoin, you decide.

Like never before, financial privacy and safe havens are under attack the world over.

Banks and even entire jurisdictions are feverishly responding to
increased government scrutiny from the world's monetary power centers in
the name of exposing political corruption, combating terrorism, and
preventing tax evasion.

Full financial transparency is the new
mantra and it's being invoked in the name of social justice. The
International Consortium of Investigative Journalists recently released "Secrecy for Sale: Inside the Global Offshore Money Maze," a report that focuses on "exposing hidden dealings of politicians, con men and the mega-rich."

But
why are private individuals lumped together with politicians who choose
to be public figures representing the interests of their
constituencies? Should private individuals and political figures be
treated in the same manner regarding financial privacy?

Attorney Jenice Malecki of Malecki Law
told me: "No, they should not. When you become a political figure, you
agree to give up some of your privacy rights. You also need to be more
transparent, so people know who you really are, whether they should
believe what you say."

Politicians who do not voluntarily submit to monitoring of their financial activities will not be trusted.

"Private
individuals should have more privacy, as they have not placed
themselves into the political arena. They have not agreed to give up
their privacy," adds Malecki. However, she also concedes that when it
comes to offshore numbered accounts, "it does seem that banking secrecy
is eroding. Slowly, but surely, banks are releasing information for
governmental investigations."

Violations of everything from know-your-customer rules to the Foreign Account Tax Compliance Act
can all be loosely categorized as the politically incorrect crime of
money laundering. But as the investor and author Doug Casey says, "it's a completely artificial crime. It wasn’t even heard of 20 years ago, because the 'crime' didn’t exist." Moving money around was simply called banking.
Furthermore, Casey says, "The war on drugs may be where 'money
laundering' originated as a crime, but today it has a lot more to do
with something infinitely more important to the state: the War on Tax
Evasion."

Almost simultaneously with the recent jihad against tax dodgers, decentralized cryptocurrencies such as bitcoin
arrived on the scene in early 2009 and now provide an outlet for
personal wealth that is beyond restriction and confiscation. The
exchange rate for government fiat currencies may be volatile now, but as
the market price eventually finds equilibrium and stabilizes, bitcoin
will become an important store of value.

Think of bitcoin as your
own personal financial safe haven or offshore bank. Previously, you had
to board a jet or hire an attorney to set up legal entities and open
bank accounts in private banking jurisdictions like Liechtenstein, Luxembourg, the Cayman Islands or the Cook Islands.

Simply by leveraging the distributed bitcoin block chain,
which records all transactions in the system and prevents
double-spending without identifying the parties by name or location,
individuals can protect their wealth from privacy violations and
indiscriminate confiscation without leaving the keyboard. This
represents a powerful new development that the world has not seen before
and it will have a profound impact on the global asset management
industry specifically.

Today's best tax havens combine a no-tax
jurisdiction with extreme banking secrecy enshrined in law where bank
employees could face imprisonment for disclosing bank customer details
to third parties or parties outside of the bank. Unsanctioned disclosure
of bank account information in most tax havens is considered a criminal
offense punishable by incarceration and monetary fines.

Sanctioned disclosure usually requires a recognized court order and typically hinges on the distinction between legal tax avoidance
and tax evasion. Offshore jurisdictions have been feeling the pressure
for several years to remove that distinction and open the banking
records regardless.

The global trend persists toward cleaning up the high-risk and uncooperative countries on the intergovernmental Financial Action Task Force’s blacklist. Ultimately, no jurisdiction will be exempt. On the complementary Organisation for Economic Co-operation and Development gray list, the tiny alpine principality of Liechtenstein
has been amending tax laws in a move to anti-secrecy compliance.
Similarly, as the small haven of Cyprus had built up a burgeoning
financial center for the free flow of capital within the eurozone, it
too had to be restrained, even if that meant egregious depositor
"haircuts" of up to 60%.

Future regulatory and confiscatory attacks on safe havens and banking secrecy will become irrelevant, because bitcoin provides for a personal "offshore center" under direct and sole control
of the individual. However, Malecki cautions, "If [the] bitcoin
currency's respect and security grows, the governments will also find a
way to keep on top of bitcoin monitoring and enforcement.

"I
think that determining 'legitimacy' is difficult," she says, "but as
with political asylum, perhaps the financial world needs some financial
asylum – which has very specific criteria, review and oversight. Without
that, there is bound to be abuse" by governments.

Legitimacy is
a politically charged term. One person's legitimacy may be another
person's aggressive and unjustifiable overreach. Also, what a certain
government sees as legitimate may be viewed in other parts of the world
as a violation of fundamental human rights. This is clearest in
authoritarian regimes that impoverish and imprison their political
opponents for so-called crimes against the state.

It all depends
of who is performing the oversight. I am not quite sure how any
political oversight could function effectively while still protecting
the financial privacy rights of individuals. Thankfully, it doesn't
matter anymore.

While some call Bitcoin an “existential threat to the state,”
local governments could soon embrace the digital currency and payment
system as a practical alternative to credit and debit cards.

E-Gov Link,
an Ohio company that helps municipalities accept payments online for
parking tickets, permits, and the like, now allows its customers to take
bitcoin. Noting that "credit card purchases tend to carry high
transaction costs due to the middleman and due to the high costs of
fraudulent online purchases," E-Gov President Bill Nadler emphasized
in a press release, "having a payment option that doesn’t carry that
heavy transactional cost is definitely a plus." Bitcoin transactions can
be processed at a fraction of the cost of other payment methods because
they avoid the interchange structure of the legacy card processors.

Aside
from the benefits to merchants, bitcoin payment choices have
significant benefits to consumers who may have already received bitcoin
from others in the sale of products or services and do not necessarily
want to convert out of the digital currency. Broadening merchant
acceptance expands the "network effect" of a young currency and starts to make Bitcoin viable as an end-to-end payments system.

"We
know the bitcoin community is passionate about using bitcoin for
payments, and will be demanding it of their local governments," said
Nadler. "We’re happy to be here to answer the call, as municipalities
scramble to find partners to help them with bitcoin."

Naturally,
the use of bitcoin in local government settings will not be leveraging
its optional anonymity properties, thus demonstrating bitcoin's overall
flexibility when compared to physical cash.

"We look at bitcoin as
a competitive advantage," says Jerry Felix, Vice President of Software
Development at E-Gov Link. The company sees it as a natural evolution
for governments to accept bitcoin as the currency gains popularity and
like in other merchant categories, supporting bitcoin first creates a
first-mover advantage. E-Gov Link focuses on integrating bitcoin
payments into the shopping cart experience while relying on payment
processor BitPay to manage the bitcoin wallets and currency conversion.

"We
have customers across the U.S., in over 30 states. We're dealing with
small and medium sized municipalities – cities, towns, townships,
villages, and counties, and we provide web solutions for them," adds
Felix. Marquee client examples for the web solutions provider include
municipalities like Niagara Falls, N.Y., and Skokie, Ill.

For
now, a municipality has to step forward and ask E-Gov Link to enable
bitcoin payments – which is peculiar because other payment methods are
not selectively disabled.

It would be far more interesting for
these local governments to make it known to citizens that the bitcoin
payment choice is an option. Still, the offering from E-Gov Link is a
major step in that direction because bitcoin first has to be a viable
option for the local government. Whether bitcoin demand is
merchant-driven or consumer-driven, one thing is clear. Greater merchant
choices and new payment categories contribute to the increasing value
of the Bitcoin network.

Payments to government entities stand as
one of the primary economic lynchpins for the preferred monetary unit.
The obligation of the political authority to accept tax payments in
government fiat currency is what underlies its value. While this E-Gov
Link move does not cover tax payments demanded in a particular monetary
unit, it can be seen as a precursor to a political authority expressing a
preference for payments in a digital currency.

Tuesday, April 9, 2013

Once you get past the childish title, the recent bitcoin piece
from Karl Denninger raises some issues that warrant consideration from
bitcoin economists. Denninger is an intelligent student of the capital
markets and his essay deserves a serious reply.

The economic contribution of his essay is that it represents the thesis advanced by German economist Georg Friedrich Knapp in The State Theory of Money (1924), an expose advocating the Chartalist
approach to monetary theory claiming that money must have no intrinsic
value and strictly be used as tokens issued by the government, or fiat
money. Today, modern-day chartalists are from the school of thought
known as Modern Monetary Theory (MMT).

Without getting into the intrinsic value debate, this is where I
strongly depart from Denninger, because if we accept the thesis that all
money is a universal mass illusion, then a market-based illusion can be
just as valid or more valid than a State-controlled illusion. What
Denninger and Greenbackers and MMT supporters
reject is the notion that monetary illusions themselves are a
competitive marketplace, falsely believing that only the State is in a
‘special’ position to confer legitimacy in monetary matters.

Regarding this issue of State-sanctioned legitimacy, bitcoin
as a cryptographic unit seeks and gains legitimacy through the free and
open marketplace. It is not a governmental instrument of legal tender
that requires regulatory legitimacy and coercion by law in order to gain
acceptance.

Therefore, the path to widespread adoption of bitcoin
hinges on three primary market-based developments: (a) robust and
liquid global exchanges similar to national currencies that can offer
risk management via futures and options, (b) more user-friendly
applications that mask the complexities of cryptography from users and
merchants, and (c) a paradigm shift towards “closing the loop” such as
receiving source payments and wages in bitcoin to eliminate the need for
conversion from or to national fiat.

Even after graciously accepting Denninger’s definition of what the
ideal currency would be (which I don’t) and searching for any economic
nuggets of value, his arguments can be distilled into four main
criticisms of bitcoin as a monetary instrument. First, bitcoin does not
provide cash-like anonymity. Second, bitcoin transactions take too long
for confirmations to be useful in everyday transactions. Third, bitcoin
exhibits irreversible entropy. Fourth, the decoupling of the stateless
bitcoin from the obligation of monetary sovereigns is considered a fatal
weakness.

Now that we identified the objections, let’s take these in order.

On the first point surrounding bitcoin anonymity, Denninger only
embarrasses himself with this criticism. By default, bitcoin may not
offer anonymity and untraceability like our paper cash today, but it is
better described as user-defined anonymity
because the decision to reveal identity and usage patterns resides
solely with the bitcoin user. This is far superior to a situation where
users of a currency are relegated to seeking permission for their
financial privacy which is typically denied by the monetary and
financial overlords. Also, his capital gains tax issue is a non-starter
because it’s a byproduct of a monopoly over money.

His second criticism of a lack of utility in the ‘goods and service
preference’ due to timing of sufficient block chain confirmations has
some merit. However, advances have been made in the use of green
addressing techniques
that solve the confirmation delay problem by utilizing special-purpose
bitcoin addresses from parties trusted not to double spend.

Denniger’s third criticism that bitcoin
exhibits irreversible entropy is confusing. Typically, entropy refers
to a measure of the unavailable energy in a closed thermodynamic system
that is also usually considered to be a measure of the system’s
disorder. In the case of bitcoin, I suspect Denninger is taking it to
mean the degradation of the matter in the universe because of his
explicit comparison to gold. While it is true that bitcoins lost or
forgotten are ultimately irretrievable, I view that as a feature not a
bug because it is the prevailing trait of a digital bearer instrument.
Two bitcoin digital attributes that make it superior to physical gold
are its ability to create backups and its difficulty of confiscation.
Furthermore, the number of spaces to the right of the decimal point
(currently eight) is immaterial to bitcoin’s suitability as a monetary
unit.

Now for the big and final one. Denninger asserts that monetary
sovereign issuers possess not only the privilege, but the obligation, of
seigniorage, which Denninger refers to as bi-directional since
sovereigns have the responsibility of maintaining a stable price level
during times of both economic expansion and economic contraction. As a
product of Hayekian free choice in currency,
market-based bitcoin is decentralized by nature and poses a false
comparison to the century-old practice of central bank monetary
manipulation. Fear not deflation.

Governments have appropriated
the monetary unit for their own benefit by declaring it the only
preferred monetary unit for payment of taxes to the State. Believing
that governments have sincere and good intentions in administering the
monetary system is akin to believing in fairy tales. Control of the
monetary system serves one and only one interest — the unlimited
expansion of the sovereign’s spending activity to the detriment of the
unfortunate users of that monetary unit. Decentralized Bitcoin
obliterates this sad state of affairs.

Denninger’s biased and establishment preference for a monetary
sovereign serves only to harm his analysis because it undeniably closes
him off from alternative, and usually superior, free-market monetary
arrangements. More damaging, however, is the fact that it places him
outside of the mainstream in free banking circles and squanders his
remaining quasi-libertarian credibility as a champion of markets.

Sunday, April 7, 2013

Largely affecting those banks outside of the U.S., the Foreign Account Tax Compliance Act
requires all foreign financial institutions to report the activities of
their American clients to the Internal Revenue Service. But given the
recent demands from other nations hinting at reciprocity, the
overreaching legislation could impact banks and financial institutions
in the U.S. as well.

Now, there is the additional element of
certain key countries rejecting FATCA outright, and the Asia-Pacific
region could end up holding the most sway.

Cited as a hindrance
to foreign investment that would ultimately dampen U.S. economic growth
and threaten American jobs, the FATCA penalties for noncompliance
provide a strong incentive for overseas investors to avoid U.S.
depository institutions altogether. Tax Management International Journal cites 11 reasons why FATCA must be repealed. Reason number one is "the height of arrogance."

It is either the reciprocity angle or the cascade effect of China's reluctance that has the greatest potential to derail FATCA.

"The
United States should be moving toward full reciprocity," Georgetown Law
School Professor Itai Grinberg, a former Treasury official, told
Reuters. He added that it would be "deeply hypocritical" for the U.S.
to ask for information on American taxpayers "without offering some kind
of reciprocity."

Because direct reciprocity may mean foreign
banks violating the privacy laws of their own jurisdictions, the
Treasury Department has started negotiating bilateral agreements so that
foreign governments can aggregate the bank data necessary for the IRS.

Attorney
Brian Mahany of Mahany & Ertl, a law firm specializing in offshore
reporting and compliance, believes that reciprocity is a bit misleading.
"We are one of the few countries that tax based on worldwide income.
Reciprocity isn't as important to most other nations," he added.

Also,
the U.S. is one of the worst offenders globally when it comes to tax
havens and "secrecy jurisdictions." For instance, Mahany said "many
people, including Chinese nationals, hide money here." While President
Obama has asked Congress for reciprocity, he is dealing from a position of weakness. "The support for FATCA is not very strong," Mahany added.

However,
with global financial transparency on the increase and more countries
considering taxation on citizen's worldwide income as a way to combat
growing budget deficits, reciprocity with U.S. financial institutions
starts to look appealing.

On the China issue, Mahany concedes
that the U.S. government will never get every nation to join FATCA and
the Asia-Pacific countries are heavily influenced by Beijing. He states,
"China is certainly an important player. Currently, none of the
Asian-Pacific countries are signed up, although Japan will probably be
the first. Without Singapore, China, Hong Kong and Macau, FATCA faces
real challenges."

James Jatras of the Repeal FATCA campaign claims that Hong Kong, like the People’s Republic of China, is not even on the list of 50 countries the Treasury claims to be negotiating with.

There
will probably be so few U.S. citizens holding bank accounts in China
that the cost of implementing FATCA outweighs the benefit to China's
financial institutions. Also, the Chinese taxpayers with U.S. bank
accounts appear to be of minimal interest to the Chinese government,
according to Lisa Smith of iExpats.com.

"Before
rushing to safe keep all your money in Communist China, remember that
even if China elects to ignore FATCA, they may still cooperate with the
IRS on a case-by-case basis," according to Mahany. China and the U.S. signed a Mutual Legal Assistance Agreement in June of 2000.

However,
none of this potentially disruptive turmoil means that financial
institutions should put FATCA-related IT infrastructure plans on hold
until China makes its decision, because foreign banks and other
financial institutions are currently ill-prepared for FATCA.

According
to Mahany, "Implementation has been delayed once but folks should not
depend on that happening again. The penalties for not complying outweigh
the risks of noncompliance."

Meredith Moss of Finomial believes
"that a technology solution is the only way to go, given the tremendous
amount of data, PDFs and paper documents to sift through." She says that
banks moving forms online and creating a comprehensive FATCA audit
trail will demonstrate diligence to the regulators and that "due
diligence should be underway by January 2014 and completed by July
2014."

Although experts in the FATCA preparation business tend to
agree that moving forward with expensive FATCA compliance plans is the
prudent and logical step to be taking now, a comprehensive and worldwide
FATCA rollout is far from a foregone conclusion. For those financial
institutions and their shareholders offended by the overreaching
legislation and lack of respect for mutual sovereignty, the cost savings
alone may start to make FATCA's non-compliance penalties look
tolerable.

This week the bitcoin exchange Tradehill launches dark liquidity, or
dark pools, for client institutions and individuals that do not want to
reveal their trading size and identity. In trading on dark pools, market participants have the ability to execute large block trades without adversely impacting the price in either direction.

Based in San Francisco, Tradehill Inc. has relaunched successfully as
a business-to-business bitcoin exchange for institutional investors and
individuals qualifying as accredited investors. The original Tradehill
founded by CEO Jered Kenna in 2011 had operations in the U.S. and Chile
and maintained a consistent second position in daily trading volume
after Mt. Gox.

Offering both a transparent open order book and a dark order book, the Tradehill service Prime
will be critical for both large investors on the buy side, such as
funds and institutions, and commercial participants on the sell side,
such as merchant processors and bitcoin mining operators.

As “liquidity” and “market impact” can be synonymous in
many cases, the market impact, especially on price, is a key
consideration for those larger institutions that are regularly shifting
assets between financial markets. If a large trade is executed
incorrectly, the market impact can be several percentage points in
addition to the typical transaction costs of commission and/or spread.

“Whether you’re trying to sell a large amount of bitcoin above
market, or trying to buy without losing your shirt to slippage, dark
orders on the Prime platform provide an important tool for larger
traders,” said Kenna.
In one week, over 100 new accredited investors signed up for
Tradehill Prime. The company requires a $10,000 minimum initial deposit
(in bitcoin equivalent or U.S. dollars) and dark orders will be priced
in BTC, trading in micro-lots of $1,000. New clients also receive a $75 account credit to test the integrated trading platform on the open order book.

Tradehill is a U.S-based exchange that falls within the definition of
FinCEN’s regulations for virtual currency exchange operators.
“Bitcoin’s primary use is value transmission and financial technology in
the U.S. is a very regulated space,” according to Tradehill COO Ryan
Singer. The company has anticipated this regulation and the recent
guidance from FinCEN “really helps the startups in the space build a
compliance game plan,” he added.

In offering dark pools of bitcoin liquidity within an exchange
infrastructure, institutional clients gain the benefits of anonymity and
non-display of orders but without losing any of the efficiencies
associated with trading on an exchanges’ public order books. With
bitcoin, it is difficult to gauge how much large-block trading occurs
off a publicly visible exchange. By comparison, research firm Tabb Group estimates that off-exchange and dark pool trading in the U.S. equity markets accounted for 32% of trades in 2012.

Emma Quinn, AllianceBernstein’s Head of Asia Pacific Trading for equities, says
” We use dark pools to access liquidity for orders we would not
normally place in the central limit order book. I think dark pools aid
price discovery. There has to be post-trade transparency but once that
happens you’ve actually got more transparency on a market than you
normally would.”

MIT Professor of Finance Haoxiang Zhu agrees with that assessment writing that “dark pools can improve price discovery in open exchanges.” He also said,
“Adding a dark pool alongside an exchange tends to concentrate
price-relevant information into the exchange and improve price
discovery. Improved price discovery coincides with reduced exchange
liquidity.”

This is precisely where the Bitcoin market needs to be heading and it
is a necessary prerequisite for Bitcoin’s evolving role in global
trade. Wholesale trading exchanges like Tradehill Prime represent an
evolution from the floating-rate and fixed-rate retail exchanges. They
can also be considered a precursor to bitcoin-based forex markets as well as more sophisticated derivatives markets for bitcoin futures and options.

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About Me

I am an e-Money researcher and a Founding Director of the Bitcoin Foundation. My career has included senior influential posts at Sumitomo Bank, VISA, VeriSign, and Hushmail.

"Free-market protagonists, such as Matonis, regard cybercash as better than traditional government-issued or -regulated money, because it is determined by market forces and thus nonpolitical in nature." --Robert Guttmann, Professor of Economics at Hofstra University, in Cybercash: The Coming Era of Electronic Money, 2002

"Matonis is quite correct that the new technology makes easier the use of multiple private currencies." --Mark Bernkopf, Federal Reserve Bank of New York, in "Electronic Cash and Monetary Policy", 1996

"Matonis argues that what is about to happen in the world of money is nothing less than the birth of a new Knowledge Age industry: the development, issuance, and management of private currencies." --Seth Godin in Presenting Digital Cash, 1995